Written by Nathan White, CFA

photo by caspermoller

“Tread carefully” is the mantra for this market because one day you are tempted to sell everything and run for the hills, and the next day you can’t believe what a great buying opportunity it is! In this environment it is best to identify quality assets, let the price come to you, and do it in small increments. Placing a large bet can lead to quick insolvency, and many are tempted to put too much capital at risk. On the other hand if you don’t buy anything as the market goes down you are also throwing away a tremendous opportunity.

These are truly amazing times. There is so much irony and doom and gloom, it can make your head spin. The smart investors are buying. For example, Warren Buffet with his smart savvy hedge funds, and I can’t believe I am going to say this, the government!

There are so many quality assets on sale, but the irony is when everyone is panicking even those assets continue to fall. Smart investors, because they have never overextended themselves during boom times, are able to take advantage of these deals and wait out the short-term volatility. That is the irony of economic busts, deals abound but the majority of investors don’t have the capital to take advantage of it!

Consider real estate. Now is the time to buy. As a buyer you can negotiate some unbelievable deals, but only if you can get a loan, which is almost impossible for anyone right now. Unless you have the cash on hand, it is nearly impossible to take advantage of the situation.

The same is true in the capital markets right now. There are great deals on quality assets, but no one can buy unless they have cash because banks aren’t lending. That is why you only see the likes of Buffet, certain hedge funds, and the government being able to buy assets in the current environment.

Written by Trent from The Simple Dollar

photo by Emma Shaw

This is good advice from Trent at the Simple Dollar for staying calm during difficult financial times.

Here are ten realistic suggestions for getting through financial turbulence without your ulcers flaring up. I myself do most of these things.

1. Stay away from pundits. The talking heads on CNBC and the other cable news channels make money off of being sensational and for making stock picks that benefit them personally. Don’t waste your time listening to any commentator. Instead, look for impartial (or at least as impartial as you can) sources for your news and information. Stick as hard as you can to facts and make up your own mind. If there’s something you don’t understand, do your own research.

2. When the market isn’t turbulent, develop an overall investment strategy. Right now isn’t the time to make major changes, but once the turbulence calms down a bit, take a look at your overall investing strategy. What are your goals? Are your investments in line with those goals? A good example is retirement savings - many people are too heavy into stocks in their retirement plans and have paid the price over the last year.

3. Stick to “timeless” investment principles instead of the flavor of the month. There are a lot of investment strategies that have worked time and time again over the last hundred years or so, both in up markets and down markets. Dollar cost averaging. Value investing. Growth investing. Stick to strategies like these, not “flavor of the month” strategies like jumping head first into dot-com stocks in the late 1990s or flipping houses in the mid 2000s.

4. Don’t sell into a sell-off. Many people were tempted to sell their stocks last week because they kept losing money. If you did that, you probably quickly saw why it was a bad idea - an immediate 11% bounce happened on the following Monday. What’s the point? Don’t make a move with your investments just because that’s what everyone else seems to be doing. You don’t make money by following the herd - you only lose money.

5. Instead, sell according to your own reasons and needs. If you have an investing strategy in place, the only time you should ever sell is when you need to withdraw your money or because something has triggered a change (reaching a certain age, for instance). Day-to-day or even year-to-year market changes shouldn’t change your strategy.

6. If you NEED big gains to reach your goals, increase your contributions, not your risk. Many people were invested heavily in stocks because they needed to hit 12-15% returns in order to retire when they wanted to. Guess what? 12-15% returns over a long period aren’t realistic. You might luck out and get those kinds of numbers over a few consecutive years (like 2003-2007), but it’ll be followed by a correction. If you need big gains like that to reach a goal, you need to be contributing more towards that goal - or you need to be rethinking your goal.

7. If you can’t state concrete, specific reasons why you’re in an investment, you shouldn’t be in that investment. This really means two things. First, you have to know what you’re investing in. Read the prospectus. Do the research. Know what it is you’re buying. You should be able to name a specific, concrete reason why you’re purchasing that investment - and past performance is not a concrete reason. You might be invested in an individual company because you believe in that company’s management or you think they produce stellar products or the company has an inherent competitive advantage over their immediate competition or they work very hard to pay good dividends to shareholders. You might be invested in a broad index fund because you believe in capitalism itself over the very long term. You shouldn’t be in an investment because it’s “hot” or because the sector is “on fire” - those aren’t reasons, those are selling points from commission-based advisors and pundits.

8. If you don’t know what you’re doing, get a fee-only investment advisor to help. If you thought you were following a safe strategy but then found out that you’d lost a lot of money, it may be a matter of simply not knowing what investments you should be in. The solution to that is to hire a fee-only financial advisor, one that does not get a commission if they “sell” you an investment package. Get some help and do things right.

9. Any money you will need in the next five years shouldn’t be in stocks. This is a good rule of thumb to follow. If you are going to need money in the next five years for any reason, don’t keep that money in something as volatile as the stock market. Move it into bonds or CDs so that you know the principal is safe. You might miss out on some exceptional gains, but you’ll also miss out on periods like the last two weeks.

10. Don’t look at your day-to-day balance. If you’re sure about your strategy and your reasoning, your day-to-day balance is just a distraction. Don’t even look at it. I haven’t looked at my retirement account balances in months. Why? I know my strategy is a very long term one, so I don’t really care that much about the short term, and I also know that seeing a value decline will do nothing more than rile me up. So why do that to myself?

Know your goals. Know your investments. Don’t make rash moves. Those are the keys to weathering any storm. Good luck.

Written by Trent from The Simple Dollar

Photo by per ola wilberg

After writing my piece yesterday on fear and the economic situation, a very eloquent reader named “Maggie” wrote to me:

“I completely agree with your assessment on the economy, particularly if you’re young. There is no crisis that is well served by panic and I don’t think that the current economic situation is anywhere near as bad as the Great Depression.

That doesn’t change the fact that many people (myself included) are looking at their 401(k) statements for the year and are seeing 20-30% drops for the year. I looked at my 401(k) and I saw that it’s down about 19% for the year.

I’m about six years from retirement, or at least that was my plan until this year. Now that I’ve lost so much money, I don’t know if I can retire then. I will probably have to work several more years beyond that, because even if the stock market goes up 20% the next two years, I’ll still only be back to about where I started.

Got any suggestions?”

Maggie tells a story that’s been repeated in the media quite often over the last week or so. My mother-in-law and father-in-law are also likely in the same group as Maggie - they’re in their mid 50s and are building a solid nest egg in their 401(k)s, but have watched some sizable chunk of that savings vanish this year.

If you’ve already lost that money, it’s gone. There’s no magic way to get back what you’ve lost. For some people who are getting close to retirement age, that means you will have to work a few years more. Your retirement date probably went from 2014 to 2020 or so. That’s unfortunate.

But the blame doesn’t go to the flailing of the stock market. The blame actually goes towards poor asset allocation in your retirement account.

Stocks are inherently a risky investment. If you look at the long term history of the stock market, there are a lot of years where the stock market goes up 15 to 20% in a year. There are also a lot of years where the stock market drops 20% in a year. Over the very long haul, these average out - that’s why holding a broad range of stocks (like in an index fund) is a good idea if you’re investing for the far future.

The problem comes in when that future isn’t quite so far any more. If you’re getting close to retirement, your investment in stocks becomes less of an investment and more of a gamble.

Think of the stock market as being kind of like a coin flip. Think of each year as being like a single coin flip, where a heads flip will get you a 15% gain and a tails flip will get you a 10% loss. The more times you flip a coin, the more likely you are to get a roughly equal mix of heads and tails results.

Since I’m thirty years away from retirement, I have a lot of coin flips ahead of me. I’ll likely see some runs of heads and some runs of tails, but over that long period, it’ll approach an even split in flips. That even split will mean a pretty good return on my investment.

But let’s say you’re now five years from retirement. That means you have only five coin flips. There’s now a measurable chance (a little over 3%) that all of your remaining flips will be bad, losing you a significant amount of money. Instead of being a volatile investment, it moves more towards being a gamble.

So what’s the solution? Most money managers recommend that as you get closer to retirement, you should slowly start taking your money out of stocks and putting it into something safer, like bonds or money markets. These investments won’t return as well over the long haul as stocks, but they’re as steady as can be - a 2% to 6% return that comes in like clockwork.

You’ll hear a lot of different methods for how to do this. My suggestion for most people is to do it automatically - simply put all of your retirement money into a Target Retirement fund that’s close to your retirement date. For example, I use a Target Retirement 2045 fund for my Roth IRA (which matches when I turn 67).

A Target Retirement fund automatically does this transition for you. Right now, my Target 2045 fund (since I’m so far from retirement) is almost entirely in stocks (and it’s been painful to watch it drop). But I have many, many years for it to rebound. When I start to get closer to retirement - in 2020 or so - the fund will automatically begin to adjust, reducing the amount of my retirement money that’s invested in stocks and increasing the amount that’s invested in other things. When I get very close to retirement, most of the money is not in stocks.

Unless you know the ins and outs of risk management and asset allocation, there’s no reason to not use a Target Retirement fund in your 401(k). Call up your plan manager and see if there’s anything like it available to you. If you want to push the risk a little bit (but, of course, remember what 2008 has been like), then use a fund that’s a little bit past when you want to retire. If you’re conservative, use an earlier fund. Then just dump all your contributions into that fund, sit back, and relax.

The next time the stock market flops, you might worry about it a bit, but it won’t be cataclysmic. You’ll be appropriately diversified without having to even skip a beat.